Reform In South Africa
by Ingrid Goodspeed,
protection is generally considered to be public measures to
provide income security to the population of a country. It
is increasingly held that assisting individuals, households
and communities to deal with the various risks they face will
accelerate poverty reduction and sustained economic and human
The elderly, specifically the elderly poor,
is one of South Africa’s most vulnerable groups. Consequently
pension systems are one of the most important institutions
in South African society because they determine the living
standards of millions of citizens of South Africa and play
a decisive role in the South African economy. This article
outlines recent developments in the application of social
protection in the form of pensions – specifically the
proposed pension reform referred to in Mr Mbeki’s state
of the nation address on 7 February 2007 and Mr Manuel’s
budget speech two weeks later. The first four sections of
the article are definitional and address the definition of
pension systems, the role of government in pension systems,
the objectives of pension systems and the key dimensions of
pension system design. Thereafter the pension reforms proposed
for South Africa will be analysed in terms of the key design
dimensions. Finally concerns around the proposed reforms will
be discussed. A glossary of terms is provided.
In the State of the Nation address on 9 February 2007 Mr Mbeki
stated that the government was exploring the introduction
of “an earnings-related contributory social security
system that is informed by the principle of social solidarity.
This will mean that all South Africans will enjoy membership
of a common, administratively efficient social insurance system,
while those earning higher incomes will be able to continue
contributing to private retirement and insurance schemes”.
Two weeks later (21 February 2007), the Minister of Finance
in his 2007 Budget Speech confirmed that “the time has
come to put in place a new arrangement in which all South
Africans will share, and that provides a basic and social
protection system that meets the needs of low-income employees.
We are therefore proposing a mandatory, earnings-related social
security scheme to provide improved unemployment insurance,
disability and death benefits targeted at the income needs
of dependants and a standard retirement savings arrangement.”
At the end of 2004 / beginning of 2005 the
total value of South Africa pension assets is estimated at
R1.5 trillion (see table 1). There were 13 609 funds with
11.4 million members.
Pension systems are designed to provide an income to those
individuals who experience a loss in earnings capacity through
advanced age, a disability, or the death of the wage earner
in the family. Pension systems can facilitate direct transfers
from the government to these particular target groups. In
addition, pension systems can provide a mechanism whereby
individuals insure themselves against the loss of future earnings.
Role of government
in pension systems
Governments generally have a two-fold role
in pension systems. Firstly they are direct providers by directly
paying pension benefits. Secondly as regulators, governments
mandate participation in pension plans of employers or private
The reasons generally cited for government
involvement in pension systems are:
- Short-sightedness: Young, healthy workers may suffer
from short-sightedness and not think about old age until
it is too late for them to take adequate steps to provide
- Moral hazard: workers may consume as much as possible
when young, with the expectation that society will care
for them when they are old.
- Long-term poverty: people are too poor to save during
their working years.
of a pension system
The objectives of a pension system are poverty reduction and
Pension systems reduce poverty by providing non-contributory
pensions to the elderly or disabled poor. The pensions are
financed directly through general tax revenues. In South Africa
the current old-age grant significantly reduces poverty among
the elderly poor and many of their dependents.
Pension systems should smooth consumption
between working and retirement years, such that individuals
do not experience a substantial drop in living standards when
old age or disability reduces their earning ability. The International
Labour Organization suggests a minimum standard of 40% of
an individual’s wage for 30 years of work.
in the design of national pension systems
The key dimensions in the design of national pension systems
- Coverage: is coverage universal?
- Participation: is participation mandatory or voluntary?
- Contributions: is the pension system non-contributory
i.e., pension are revenue-financed and means-tested or
are contributions earnings-based?
- Benefits: to what extent do benefits i.e., annuities
reflect the life expectancy of a retiree at retirement?
In this respect there are two schemes under consideration:
defined benefit and defined contribution schemes;
- Funding: to what extend do fund assets cover future
fund liabilities? Financing mechanisms are generally of
two types: pay-as-you-go or fully funded.
- Management / ownership / governance: is the system public,
private or a mix of the two?
Analysis of the pension reforms proposed for South Africa
The World Bank’s benchmark for pension
systems and reforms is detailed in its publication Old-age
income support in the 21st century, which suggests a pension
system should be composed of some combination of the following
- Pillar 0 consists of a basic or social pension that
provides the minimal level of social protection. It is
funded out of national budget or general reserves;
- Pillar 1 is an earnings-linked contributory public
pension plan that attempts to replace some portion of
income upon retirement. It is funded out of contributions
with some financial reserves.;
- Pillar 2: is a mandatory fully-funded obligatory occupational
or personal pension plan;
- Pillar 3 is a voluntary fully- or partially-funded occupational
or personal pension plan;
- Pillar 4 comprises other sources of support to the
elderly such as informal family support, formal social
health-care and housing programs and access to individual
assets such as home ownership.
South Africa’s current standpoint on
pension fund reform is outlined in National Treasury’s
discussion paper Social security and retirement reform published
in February 2007. It proposes a multi-pillar system consisting
- Pillar 0: social assistance grants
- Pillar 1: mandatory national social security system;
- Pillar 2: mandatory private occupational or individual
- Pillar 3: voluntary supplementary savings.
From information in the discussion paper,
an attempt has been made to analyse these pillars against
the key elements described in item 5 above. This is shown
in table 2.
This proposed multi-pillar approach conforms
to the World Bank’s benchmark. Therefore its implementation
should provide a social safety net and be an instrument for
growth. However as National Treasury admits: “there
is a great deal of further work to do in developing the details
of the proposed social security system and associated retirement
the proposed reforms
Ideally pension fund reform should specifically cater for
the informal sector.
National Treasury does seek to encourage
voluntary participation in Pillar 1: National social security
system by those in the informal sector. However there is no
indication as to how this will be done. This is not surprising
as it is particularly difficult to collect contributions from
workers who are not part of the formal sector. Even determining
income for groups such as farmers and the self-employed is
easier said than done.
As an alternative to voluntary participation
in pillar 1, expanding social protection reform to the poor
informal sector could be fostered by the private-sector development
and launch of micro-savings and micro-insurance products that
can effectively and efficiently assist in long-term asset
Decisions of the poor dominated
by short-term risks
The poor and very poor are exposed to diverse risks during
their lifetime and old-age income provision is generally not
high on their agenda. Vulnerability due to insufficient resources
in old-age is likely to be dominated by short-term risks such
as sickness, drought, flooding, unemployment and disability.
Thus mandating participation in a public, earnings-related
pension scheme for the very poor may be welfare decreasing.
In addition its success will be highly dependent on a strong
immaculate administrative environment.
Public administration of national
There is political risk in the public administration of pension
funds. The risk ranges from restricting investments and investment
returns to fund confiscation to meet political ends. In addition,
governments and public institutions have repeatedly made decisions
on old-age programs based on short-term demands rather than
Public administration of South African national
funds has a poor track record. Recent events include:
- In a briefing to Parliament’s transport portfolio
committee in March 2007 on the Road Accident Fund’s
three-year strategic plan, the CEO reported that while
the RAF had attained some stability, it was still insolvent.
The fund has been troubled by a backlog of claims, high
administration costs and widespread fraud and corruption.
Its outstanding claims amount to R24bn nominal (actuarial
liability of R32bn).
- The 2005/06 financial statements of the Compensation
Fund were disqualified because the auditor-general was
unable to determine accuracy and completeness of the revenue
contributions for the year of R2.9bn.
- In September 2006 Parliament’s standing committee
on public accounts resolved to request the auditor general
to conduct a special investigation into the Unemployment
Insurance Fund (UIF) to ascertain the cause of the UIF’s
continued non-compliance with laws and regulations including
the Public Finance Management Act.
National Treasury has not ruled out private
sector administration and fund management and has indicated
that this will be the subject of research and consultation
during 2007. Should the decision be that a government agency
is to undertake the administration and fund management of
the national social security fund, the agency should subject
to the same governance, risk management, transparency and
disclosure requirements applicable to the private sector.
“Income insecurity in old age, and the vulnerability
of families to death or disability or unemployment of a breadwinner,
are challenges faced by all, rich and poor. South Africa has
a well-established occupational and individual retirement
funding industry that provides protection to many, and a substantial
social assistance grant programme that provides income support
to the poor. But between the means-tested grant programmes
and tax incentivised saving, there is effectively no fiscal
support for saving and social insurance; the basic, contributory,
earnings-related social protection system is incomplete and
uncoordinated.” (National Treasury 2007 p 38). It is
this disconnect that the proposed pension reforms attempt
to address. As always, the most difficult part of planning
and implementing something is the detailed design rather than
the overall concept.
Under a defined-benefit
scheme, the benefits are defined, thus the final pension
a member can receive is pegged, usually as a function
of income expressed as a percentage of income per
year of contribution. Should financing fall short,
either the government in a public plan or the employer
in an employer-based plan, must provide the pension.
Thus the government or employer bears the risk in
Defined-benefit systems can be pay-as-you-go
or fully funded. If fully funded, financial assets
are sufficient to cover the plan’s liabilities.
However, should investment returns fall in any particular
year, employers are obliged to offset the lower returns
by increasing their contribution.
Under a defined-contribution
scheme the contributions are defined hence the final
pension is a function of the level of an employee’s
and employer’s contribution plus any returns
on investment. The contribution is specified as a
percentage of wages, and contribution rates are specified
for employees, employers and potentially, the government.
The final pension is determined by the amount in the
retiree’s pension account at time of retirement.
Members bear the risk in defined-contribution systems.
|Pay as you go
Pay-as-you-go plans offer defined
benefits that are not actuarially linked to contributions.
In pay-as-you-go pension systems, current workers
make contributions based on their current earnings.
These contributions are immediately used to pay benefits
for current retirees. The workers making the contributions
receive a promise from the government that it will
pay benefits related to these contributions when the
workers become eligible for a pension
In fully funded pension systems,
the financial assets of the plan are sufficient to
cover the plan’s liabilities. Worker contributions
are invested and investment earnings form an integral
part of the benefits eventually paid.
|Fund sponsor / plan sponsor
Entity that sponsors a pension
fund. This could be a company or the government.
Public measures to provide income
security to the population
Fox, L and Palmer, E.,
1999 (September), New Approaches to Multi-Pillar Pension
Systems: What in the World Is Going on?, International
Social Security Association.
Holzmann, Robert and
Hinz, Richard, 2005, Old-Age Income Support in the 21st
Century, World Bank (www.worldbank.org).
Minister of Finance,
2007, Budget Speech, www.treasury.gov.za.
Myners, P., 2002, Institutional
Investment in the UK, www.hm-treasury.gov.uk.
National Treasury, 2004,
Retirement Fund Reform, www.treasury.gov.za.
National Treasury, 2007,
Social Security and Retirement Reform, www.treasury.gov.za.
President of South Africa,
2007, State of the Nation Address, www.gov.za.
Schwarz, 2006, Pension
System Reforms, World Bank (www.worldbank.org).
World Bank, 1994, Averting
the Old Age Crises, World Bank (www.worldbank.org).